What is Non-performing Loan?

Legal Definition
A non-performing loan, or NPL, is a loan that is in default or close to being in default. Many loans become non-performing after being in default for 90 days, but this can depend on the contract terms. According to International Monetary Fund, "A loan is nonperforming when payments of interest and principal are past due by 90 days or more, or at least 90 days of interest payments have been capitalized, refinanced or delayed by agreement, or payments are less than 90 days overdue, but there are other good reasons to doubt that payments will be made in full". By bank regulatory definition, non-performing loans consist of:

  • other real estate owned which is taken by foreclosure or a deed in lieu of foreclosure,
  • loans that are 90 days or more past due and still accruing interest, and
  • loans which have been placed on nonaccrual (i.e., loans for which interest is no longer accrued and posted to the income statement).

In India, non-performing loans are common in the agricultural sector where the farmers can't pay back the loan or the interest amount mainly as a result of losses due to floods or drought. Generally NPL problems are resolved in two ways:

  • Centralization – This happens when all the concerned parties including the banks, regulators and government get together to find solutions. This generally takes the form of a central organization/agency such as an Asset Management Company.
  • Decentralization – This approach involves steps taken by the affected banks. The decentralized approach is common for bad loans arising from bad lending. In this approach, the banks are left alone to manage their own bad loans by giving them incentives, legislative powers, or special accounting or fiscal advantages.

Worldwide, the most common and successful approach towards NPL management is the establishment of Asset Management Companies (AMC). These companies use public or bank funds to remove NPAs from the bank books. For example, the Korea Asset Management Corporation purchased as much as 80% of bad loans at market rate following the Asian crises. Now, there are several proactive measures that are being implemented:

  • Corporate Governance
  • Better credit information to cut down on fresh NPLs
  • Prudential Supervision
  • Efficient, capable management
  • Well developed capital markets that can offer the mechanism and liquidity required to write off bad loans
  • Securitization
-- Wikipedia
Legal Definition
A loan no longer receiving regular payments.